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Tuesday, July 12, 2011

I Fled China. Now How Can I Still Make Money There?

I got out of China a few months back, and with good reason. With Chinese stocks listed on American exchanges being proven as frauds left and right, I'm not willing to take my chances on owning any right now.
While efforts are underway to provide some transparency and oversight, I think an environment of trust is still a long way off.
With that in mind, I wrote off Chinese stocks.
But does that mean I have to write off the possibility of making money there?
Let's face it, China is the world's fast-growing economy. Its hunger for energy and for materials grows.
It also has a burgeoning middle class eager to consume.
There's a lot of money to be made there, and somebody's going to make it.

But how do I get a piece of that pie without exposing myself to the risk of investing in a Chinese company that's cooked its books?

I see two possibilities:

Investing in an exchange-traded index fund (ETF) with exposure to China.

Investing in established, non-Chinese companies who have a growing customer base there.

An ETF seems like the easy answer. There are more than 25 ETFs dedicated to offering investors access to China.
Each one (that's not a leveraged fund) is invested in at least a two dozen Chinese companies. These give investors the chance to access China while spreading out their risk across many companies, rather than just a few.
Sounds good at first blush, but I see problems, including two glaring ones.

Bigger basket, not better basket
There are only so many Chinese companies available to invest in on American exchanges. When you build a bigger and bigger basket, you're adding poorer companies to the ones you might like.
Slow growers mix with good growth stocks. Dead money waters done attractive prospects. What you end up with seems to be a pretty weak tea.
I've read that there's a better breed of Chinese companies available on Chinese and Hong Kong exchanges.
But stocks on those exchanges also face less transparency and reporting rules as those on the American exchanges. So, you're essentially trading one risk for another.

And about that risk
The second problem is also one of risk. ETFs that are dedicated to Chinese-based corporations -- on any exchange -- are not protected from more widespread fraud in China. If the problems with cooked books are systemic, then an ETF may only fool investors into thinking our money is safer.

A better alternative?
Which brings me to Option No. 2 -- Investing in non-Chinese companies that sell goods or services in the country. Not my initial pick, mostly because I saw myself needing to load up on a bunch of companies to get the same exposure to China as one ETF purchase would offer.
This option quickly became more attractive to me, for a few reasons.

You choose these companies based on their fundamentals and real prospects for growth, not just in China, but worldwide.

You choose companies you're more familiar with, that have established themselves in the U.S. and other parts of the world.

You're in better command of what you own. Keeping tabs on a few companies is a little work each week. Keeping tabs on 50 Chinese firms in an ETF is impossible for a lay investor.

You don't have to invest all at once. No need to plunk down 10 percent of your portfolio tomorrow on the FXI. You can add companies youI like over time, building up your China exposure with quality investments.

In fact, I've already started.
Ford's sales in China grew 19 percent over last year. Apple may triple revenue from China over the next two years, analysts say. Berkshire Hathaway owns a large share of Chinese automaker BYD.
Those are three of my largest holdings.

More to come
I'll be taking a look at other companies that I can add to my portfolio for China exposure in upcoming blogs.
Until then, I'll stay satisfied with the exposure I already have.

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The Blogger

Reporter by day. Stock portfolio manager by night. I've been at it since just before the 2008 crash. I'm still learning everyday.
This blog is where I share my triumphs and my errors. Feel free to share some of yours.